Commentary on Political Economy

Friday 12 August 2011

Origins of "the Fracture": Finance Capital from Great Moderation to Financial Crisis

For the more theoretically inclined friends, here is another excerpt (following the one on Mishkin) from the "Notes On Minsky" chapter in 'Krisis'.

On a walk through Princeton's verdant grounds and lawns, amidst pleasant replicas of European architectural styles, from English Gothic to Italian Renaissance to Greek neo-classic, the great Italian monetary economist and historian Marcello De Cecco once explained to me how the cultural milieu at this academic establishment in New England had been shaped by the German Jewish "refugees" who had fled the horrors of Nazism - until we passed, on our way to lunch at Graduate College, the house where Albert Einstein resided "in this friendly country and this liberal atmosphere". As a graduate student from Cambridge, England, I was welcomed with astounding hospitality by members of the Economics Department (Peter Kenen even found time to read and comment on my Ph.D. thesis early draft!) in what seemed an Arcadian citadel of enlightenment. Aufklarung.

It seems no coincidence to me that, apart from Kenen, illustrious economists like Paul Krugman, Michael Woodford and now Professor Shin (formerly at the NY Fed) have joined the departmental staff. One such member, until promoted to the Chair of the Federal Reserve, was Professor Ben Bernanke, of course. And it is in this Princetonian context that we need "to situate" him. It is a context that we may describe as "Princeton Enlightenment" - right there in the heart of New England, a short distance from Manhattan and Wall Street, at the nerve centre of the capitalist world.

I make this introduction because it is vital to understanding what I call "the fracture" in the American ruling elite between "Progressives" who have a new vision of how a modern society should function and evolve from its capitalist origins, and those "Conservatives" who (in the words of FD Roosevelt) would have us return "to the days of horse and buggy". One of the chief "ailments" (Freud would call them "neuroses") of capitalism is "fear" - not least "fear of stagnation", of that "liquidity trap" that Keynes theorised and Krugman reviewed (here ) in relation to Japanese deflation and which is brought about by the existence of "money", which Keynes described as "the bridge between the present and the future". It is this "fear" that paralyses capitalist society - the fear of the future, the fear that the present (the capitalist established order) is in conflict with the future (the need of capital to allocate social resources only if they yield a "profit" when this outcome is obstructed by the antagonism of us "workers", that is, by all those who produce social wealth but have next to no say in "how", "what" and "how much" is produced).

Once again, it is in the context of this capitalist "fear" and the "Rooseveltian Resolve" (Bernanke's phrase coined here ) that is needed to overcome it that we must begin to analyse the conduct of monetary policy under the current leadership at the Fed.

Keynes introduced "uncertainty" to economics, just as Freud introduced "neurosis" to psychology and civilisation. Uncertainty is what separates the capitalist present from its future: and "money" is the means of "bridging" these two. Just as Schumpeter was initially wrong to believe that "entrepreneur" and "capitalist" were two "separate" persons, so were Keynes and Kalecki wrong to believe that borrower's risk and lender's risk are two "separate" entities: - they are merely "functions" of capital. It is false and meaningless to say that "risk is the engine of capitalist growth". Capital does not seek "risk" - if that were so the entire earth would have been laid waste by now! Capital seeks "safety" - "safe profits", to be exact. The "lending function" is that "aspect" (Bild) of capital that seeks at least the return "of" capital; the "borrowing function" is the one that knows that for capital even "to preserve itself" it must go through the mortal danger of "investment". No "profit" without "investment". The "lender" is the present, and the borrower represents the future. By the process of lending "money-as-capital" to the borrower, the lender "invests" in the future - because without "investment", without being perennially "in circulation", capital cannot even "preserve" itself, let alone "grow" and "be profitable" ("Accumulate! Accumulate! That is Moses and the prophets!").

So there can be no "information asymmetries" between borrowers and lenders - because both are "internal functions" of capital. Therefore, "risk" (both borrowers' risk and lenders' risk) can determine only (through higher interest rates) the internal "distribution of profit" between capitalists - but it cannot determine "profit" itself! "Risk" is the capitalist "projection" into the future - the "expectation" of the likelihood of "profit". When this "expectation" is beset with and devoured by "uncertainty", we have a "liquidity trap", we have... "the zero bound" (see M Woodford and Eggertsson, "Monetary Policy at the Zero Bound" here http://www.scribd....licy-at-Zero-Bound ). When the "expected" profit is minimal, capital prefers to bide its time and remain "liquid", "ready-at-hand".

But what is the "ultimate source" of this "uncertainty"? (Fahr et alii, "Lessons for monetary policy strategy" at page 6, here Few, if any, monetary economists will answer the question properly: they will point to "higher interest rates", "higher uncertainty", or "information asymmetries" (see F Mishkin, "Spread of Financial Instability" here ).

But in reality, the antagonistic reality of capitalist society, is that in order "to valorise" itself and emerge from the crucible of the production process in the shape of "products" that can be sold to yield a "profit", capital must first contend with "us" - the workers, in the workplace and, increasingly, in "the society of capital" at large.

So we know that capital seeks “to valourise” itself as “safely” as possible – indeed, if this circle could be squared, capital would “wish” to be “profitable” as “naturally” as trees bear fruit! (- Whence comes the notion of “fructiferous capital” and of that more ignominious one, the Wicksellian “natural rate of interest”! – or finally that most infamous of bourgeois phantoms, “the natural rate of unemployment”!)

And when, in one fell swoop, two decades ago, one of the most bestial dictatorships this world has ever seen, the Chinese Politburo, decided to make “the great leap forward”, all the prayers of capital seemed to be answered – it was Christmas all year round! Here were a billion potential “workers” that could produce consumption goods to keep workers in advanced capitalist countries “pacified” and maintain nominal wages stable whilst the cost of wage goods for capitalists declined dramatically! This was the basis of the Great Moderation. Again, Fahr at alii fail to mention this, and list the “effects” rather than “the ultimate source”: “The period before the financial crisis, known as the great moderation, was the result of a number of factors that can be grouped into: a) structural change, e.g. better inventory management (McConnel and Perez-Quiros, 2000) or financial innovation and better risk sharing (Blanchard and Simon, 2001), b) improved macro-economic policies, such as the establishment of stability-oriented monetary policies, and c) good luck, i.e. the absence of large shocks such as the oil price crises of 1974 and 1979.11 The relative importance of those factors has been hotly debated, but all three factors are likely to have contributed to a reduction of volatility.12”

It is this paper by Blanchard and Simon ( ) that Bernanke mentions in the very first paragraph of his address launching the phrase “the Great Moderation” (here ):

“One of the most striking features of the economic landscape over the past twenty years or so has been a substantial decline in macroeconomic volatility. In a recent article, Olivier Blanchard and John Simon (2001) documented that the variability of quarterly growth in real output (as measured by its standard deviation) has declined by half since the mid-1980s, while the variability of quarterly inflation has declined by about two thirds.1 Several writers on the topic have dubbed this remarkable decline in the variability of both output and inflation ‘the Great Moderation’”.

A remarkable decline, indeed! So remarkable that finally it seemed as if central banks could be given a “technical mandate” to target inflation simply by means of small “corrections” to the interest rates they set – and this could be “set in stone” even in bourgeois constitutions as part of “economic management” without the need to bother about anything else. “The Jackson Hole Consensus” (the last mantra spun out of “the Greenspan put”) was that “asset prices” are not and cannot be the concern of central banks – “price stability” alone will suffice, and “the market” will take care of the allocation of capital to various investments. The entire wave of “financial deregulation and liberalisation” that culminated with the repeal of the Glass-Steagall Act by the US Congress in 1999 gathered its tsunami-like strength from this “Great Moderation”.  (The tide of capitalist opinion toward “privatization” from the ‘80s is wonderfully summarized by the doyen of Italian central bankers, T Padoa-Schioppa in this, “The Genesis of EMU”, here )

Because, just as in the 1920s under Fordism, the sudden reduction in the cost of wage goods for capital made possible by the opening of “the Chinese frontier” could allow capital “to undo”, to demolish and reverse what had been the unstoppable and ominous expansion of the role of the State in the US economy and worldwide. The industrial analogue of “financial liberalization” was the “re-privatisation” of entire areas of social productive activity that had fallen under the direct management of the State since the New Deal. The unprecedented profits and “global savings glut” (again the title of a Bernanke speech, here ) coming from China and other “emerging economies” that were concomitant with the “globalization” of the capitalist economy (see P Lamy here )  – all this had “silenced” the real “motor”, the true “engine” of capitalist accumulation, just as Fordism did in the 1920s – the working class, the antagonism of workers in the workplace and in society, the one and only true “test” of the real “value” and “profitability” of capitalist “investment”!

Without its continuous “conflict and confrontation” with living labour (with workers) in the workplace and in society, capital is deaf and blind, it has “no senses” because it cannot “gauge” the actual political command it can exercise over workers and over society at large without encountering their “resistance” in its stage of “valourisation” (the productive process) and “realization” (the sale of products). The real life of capital is precisely this: - command over living labour in the process of production – a “process” that through workers’ antagonism then becomes “extended” to the whole of “society” and that causes “the State” to intervene (and “interfere”!) in the notionally “private” capitalist “market” economy. To the extent that capital fails to engineer “growth”, the State needs “to control growth”, and this leads inevitably to the “growth of its control” over the economy and the society of capital as a whole.

The “retreat” from the New Deal “expansion” of State activities is what “the Great Moderation” allowed. Capital seized the opportunity with both hands. Previously, as Hyman Minsky had perspicaciously shown, the State had been called upon to play an ever-growing role as “the collective capitalist” to rescue the capitalist economy from its frequent crises, its booms and busts, but each time at a higher level of social antagonism, culminating in the social struggles and high inflation of the 1960s and 1970s. Now, commencing with Arthur Burns and Paul Volcker at the Fed in the late ‘70s and through the ‘80s – now was the opportunity “to re-launch” the capitalist dream of a “self-regulating market economy”. And this is what happened through the Reagan years up until 2007.

We were saying – “the global savings glut”. The breathtaking growth of the Chinese economy as the “assemblage hall” of consumer goods for export to developed economies generated massive amounts of capital (savings) that the Chinese dictatorship could not “re-invest” in domestic consumption for the simple reason that this would hasten the rate of politico-economic “emancipation” of its own workers. All dictatorships integrated in the capitalist world “market” have this good reason to privilege “exports” by (a) suppressing domestic wages and (b) siphoning off capital from domestic consumption, providing in effect “export subsidies” to their leading firms which are owned exclusively by members of the elite (from China to India to “you name it”, and this includes the German elite which, with its Junker and Nazi past has a brutal track record of mercantilism [cf. Schumpeter’s classic study on ‘Imperialism and Social Classes’]). (On China, its mercantilist policies and the Fed’s reaction, there is no greater authority than Michael Pettis at )

Too many Marxist and left-wing critics of the capitalist economy preach the mantra that what causes capitalist crises is the “underconsumption” of goods produced due to excessive “oligopolistic accumulation”. (Keynes and Kalecki started this neo-Ricardian fable, aping Rudolf Hilferding’s ‘Imperialism’ thesis, and were then embraced by Piero Sraffa and Paul Sweezy and several strands of “post-Keynesians”. Cf this review by JB Foster on “The Financialisation of Capitalism” ). It is quite ludicrous to argue that workers are unable to consume what they produce or simply that capital cannot be invested “profitably” because there are no “opportunities” for investment. This leads to a certain “defeatism” and, more important, fails to explain why indeed, given the more “skewed” distribution of income and capital ownership, actual social “tensions” rise both within nation-states and between them.

In reality, the problem arises for capital when the “savings” generated by “profits” cannot be invested any longer “profitably” because the growth in employment and consumption or wages ends up “emancipating” workers. This leads to “wage-push” and “demand-pull” inflation, with all the attendant problems that that causes in terms of “price stability” and the normal functioning of debt contracts (which become short-term and impossible to fix predictably). (The link between “Capitalism, Conflict and Inflation” is traced admirably by my Cambridge supervisor Bob Rowthorn in his homonymous book). The “crisis” then becomes “real” and is not just a creature of “excess” or of “casino capitalism”. The “conflict” is real, not engineered artificially (by Finanzkapital) or wholly “internal” to the dynamics of capitalist accumulation. We will focus on these matters very shortly.

But the essential characteristic of “the Great Moderation” was the absence of inflation in developed economies, and the “global savings glut” represented by the regurgitation or re-cycling of Chinese dictatorship profits into “parked savings” in US treasuries and other “financial investments”. Combined with the “absence” of the working class from wage and industrial disputes, this greater availability of social resources in the form of “capital” could only be “invested” by exasperating the “financial” side of capital – through “credit creation” and “leveraging” that resulted in “asset-price speculation”. As Minsky and then Mishkin explained, low inflation encourages the “lending” of capital at low rates of interest and the “borrowing” for longer contract terms in the “expectation” of higher future income streams from investment in financial assets. As the market price of assets on balance sheets of firms rises, the “Value at Risk” of debt-financed investment falls inducing capital into what Adrian and Shin have called “the risk-taking channel” ( - see also J Nocera on “Risk Management” here ). From there to the collapse of what becomes eventually “Ponzi finance” (Minsky) once the “expected” income stream from over-valued assets fails to be “realized” – in other words, once capital can no longer be “valourised” in the production process -, the road is very short indeed.

Once again, it is the “absence” of the working class, the “absence” of the real “motor or engine of capitalist growth”, the real “acid test” of antagonism and conflict in the production process that allows “the rising tide that lifts all boats” (asset bubbles) which, once it recedes, exposes “those who have been swimming naked” (Warren Buffett). But the problem is precisely this! That by that stage it becomes impossible to tell which “investments” are “real” and which are “fictitious” (the infamous “mark to market”)!

Worse still, in the financial sphere, the implosion of asset prices and contracts and the consequent “debt-deflation” (correctly theorized by Irving Fisher here  ) threaten to destroy not just “value” but indeed “markets” themselves – chief among them the “inter-bank loan market” which allows the vital “metabolism” of capitalist “equiparation” of loans across disparate branches of capitalist investment and social production – necessitating the use of exceptional “unconventional” measures by monetary authorities that in some cases may lie well beyond their legal mandate (see FT article here )!

As Lahr et alii linked above put it: “Malfunctioning interbank and other financial markets called upon central banks to take on a more active financial [p.2] intermediation role. They also highlighted the fact that there was no longer a single market rate due to the collapse of normal arbitrage activities. Second, because monetary policy had to be eased beyond what is possible by reducing short-term interest rates close to their lower bound at zero, a number of central banks had to pursue alternative policies of quantitative and credit easing. The notion that the policy-controlled short-term interest rate is the sole tool of monetary policy has therefore been questioned.”

So now we come closer to the heart of the rationale of capitalism: - the efficient allocation of social resources (what they call “capital”) under the control of capitalists (now [!] it becomes “capital”!). (This point is intended to enlighten all those who wish to have capital… without “the capitalist”! Because capital is not a “thing” – it is a social relation of subordination and exploitation of workers by capitalists.) The question here is that, given that it is real social antagonism and conflict over the wage relation that occasions the “asymmetric information problems” (moral hazard, free-rider and principal-agent) and not rather these “asymmetries” themselves (as Mishkin on behalf of all bourgeois economists suggests) – given this reality, what has been and is “the present strategy” of capital (both “private” and “social capital” acting through the State, or “the collective capitalist”)?

As mentioned above, underconsumptionist theses tend to overlook entirely the “conflict” of which financial crises are clear evidence – precisely because they are seen “only” as “financial” and therefore “fictitious” in nature given that they seem to arise “outside” the sphere of production. JB Foster, for instance (see link above), dismisses De Brunoff’s statement in ‘Marx on Money’ that financial crises are tied to “real relations of production”, wrongly suggesting that she fails to understand the “reality” of credit crises. Now, to the degree that financial crises are “real” and not as “fictitious” as the capital created, it is only because they arise directly from the “conflict” that capital experiences in the process of “valourisation”. The problem with this misapprehension starts perhaps with the very notion of “surplus value” which, whilst it denotes a higher “rate of exploitation”, also seems to suggest that capitalists accumulate a “surplus” that gives them a “margin of manoeuvre” in dealing with living labour. But this is clearly wrong because, regardless of how large this alleged “surplus” is supposed to be, its “value” quickly “collapses” as soon as a “crisis” occurs – often in just a matter of hours! (The point is made powerfully by Kaminsky et al. on “Fin. Contagion” here ). In this regard, whilst it is true that Marx considered capital’s “velleity” for a miraculous leap to profit (M to M’), it must be stressed that he regarded this purely as “ideology”, whereas he considered financial crises to be not only “real”, but indeed “critical” to the analysis of capitalism itself! It is the growing opposition or “conflict” between the need “to socialize social resources” and the need to socialize “the losses” that capital’s attempt “to elude” this conflict engenders – it is this “conflict” that is “real”! Small wonder Foster, and post-Keynesians from Kalecki and Steindl to Sweezy and Minsky, dreamily find many similarities between Marx and Keynes where very few indeed exist!

It is possible to gain a strong insight into the nature of the “ailment” (almost a Freudian “Unbehang”) of late capitalism by returning to the conclusions reached from our review of Mishkin. We saw there the contrast that has developed, to the point where it induces chronic “crises”, between the need of capital to retain its independence from social control – because in that case it would lose its essential characteristic as “command over living labour” -, which occurs through deregulation and liberalization of “markets”; and then, on the opposing side, the fact that each time such “deregulation” ends up in catastrophic “crises” that require the massive “systemic intervention” of the State to rescue the capitalist economy, with consequent “expansion” of the role of the State which “deregulation” was supposed to curtail! Thus, each time that an attempt is made by the collective capitalist (the State) to allow “private capitalists” to run the economy, the end-result is the re-assertion and aggravation of the “control of growth” by the State. The problem is that “private capital” is incapable of achieving anything like balanced growth of the economy and that each time the State is forced to intervene the level of intervention required is aggravated and its “effectiveness” constrained by the amount of “public debt” accumulated in the preceding “rescue operation”. The result is a “fiscal crisis of the State” whereby “taxpayers” end up paying for what, in the period of “deregulation”, were “private profits”. (De Cecco describes this process “encomiably” well here )

At this stage, however, a new “fault-line” appears in the system, because now the ability of the State to operate a return to “growth” within the parameters of a “capitalist” economy – that is, if it is to respect its legal, proprietary and contractual rules, with a modicum of “privacy”, or indeed simply to maintain the “market price mechanism” (we already see suggestions, like REA Farmer’s, of direct intervention in asset markets) – in order for the State to do so, its “room for manoeuvre” becomes exceedingly small and restricted, so that essentially we reach an impasse, an “insuperable” limit where the only way forward is… to abolish the “barriers” to social activity – which are ever more “visibly” the legal categories of capitalist ownership and control over production and society.

The first dilemma lies between “regulation/supervision” and “deregulation/liberalization” to allow “market allocation” of social resources. This results in “moral hazard” because the “public/State insurance” of the “private economy” leads the latter (the capitalists) “to game” the rest of society in the knowledge that the “social insurance” of private investment will secure their “ownership and control” of social resources. Economic authorities therefore have to engage in a game of “cat and mouse” with private capitalists in order to induce them to invest “as private owners” by utilizing ever more “public” means, methods and resources in order to preserve the reproduction of society itself! Price stability is one target, but “leaning against the wind” and all manner of “unconventional” or “non-standard” measures are required (from QE to “announcement effects” to guide “expectations” – or ultimately direct investment by the State to maintain aggregate demand!).

The second dilemma then takes hold, of “State supervision” being insufficient or “collusive” with “private capital” and therefore not representing “democratically” the interests of “society” which are antagonistic to those of “capital”. De Cecco speaks here of “credit channels” that increasingly seem to be “informal” and channeled into “too big to fail” institutions. And, most important of all, of the fact that the State itself must fail (because of the fiscal and legal constraints) in its task “to revive” the capitalist economy – which is what leads to the paralysis and “fracture” of the “Crisis-State” (and, perhaps, even of the bourgeoisie itself!). In a nutshell, it seems, this is the manifestation of the Marxian notion of “capital becomes a barrier, a limit, to itself” (Grundrisse).

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